Sit down with any entrepreneur or investor in the world and the topic of valuation is sure to pop up. And who can blame them? It’s a lightning rod topic that can make or break a startup, regardless of which tech hub you call home.
According to 2010-2014 data on AngelList, the average angel valuation for Silicon Valley tech startups clocks in at an astonishing $4.7 million – more than 10% higher than the average valuation of N.Y., Boston or Seattle-based startups. When you go overseas, the gap becomes even more pronounced. Perhaps most surprising is that Israel is the second largest startup ecosystem in the world, generating an estimated average seed valuation of $1.5-$2.5 million based on research and conversations with some of the most active angels in the ecosystem.
I am most interested in how these valuation gaps affect Israeli-based startups. As a venture capitalist and entrepreneur, I started the iAngels network with my partner Mor Assia to serve investors around the world interested in investing in high-tech in Israel. As an analyst at heart, valuation is a sensitive subject. It is the main driver of investor returns so it was important for us to understand it from an industry perspective and versus some of the alternatives. When I couldn’t find data driven literature on the topic, I decided to research it myself.
In the last 1 year, Israel has generated three near-billion dollar exits alone with Waze, Wix and Viber and one over 5 billion – Mobileye. Almost every angel investor that we’ve met has agreed that Israel is at least comparable to New York City and Silicon Valley when it comes to startup output, entrepreneurial talent and a robust support system.
So why is it that these ecosystems that share so much in common can command such different valuations? Should investors care? And does it even matter when it comes to predicting returns? Yes, and not necessarily.
While it’s true that the U.S. and specifically Silicon Valley has on average generated more household names like Facebook and Twitter, we think there’s more to the success story than just looking at the number of much-hyped, rare exits.
Let’s consider the amount of venture capital available to tech startups in these ecosystems. We believe that startups in Israel receive less funding simply because there’s less available capital as angels and VCs prefer to invest locally. This causes startups in Israel to scramble over limited venture capital. In Israel, there are a couple of dozens of angels and VCs over ~3,000 startups. According to our research, approximately 1,800 Silicon Valley startups received $20.5 billion of funding since April 2012. During the same time, 1,255 Israeli tech companies raised around $4.5 billion of funding.
Secondly, let’s take a look at the returns coming out of U.S. tech hubs versus Israel. Last year, CrunchBase found that the average successful U.S.-based startup raised $41 million and exited at a little over $243 million, implying a value creation ratio of 5.9x. We did a similar exercise for Israeli startups in order to understand whether or not the valuation gap was a predictor of investor returns.
Using the same methodology applied by CrunchBase, we found that since 2011 the average successful Israel-based startup raised $28 million and exited at around $192 million based on IVC Research, implying a value creation ratio of 6.9x. Keeping everything else constant, it appears that the average return profile of Israeli startups is at the minimum, not inferior to that of their U.S. colleagues and potentially better.
It’s also important to consider more than just the total size of the exits. From 2011 to October 2014, there have been around 4,600 exits in the U.S. out of 60,000 startups and around 360 in Israel out of 3,000 startups. Thus, the implied “exit rati o” during this time period was 8% in the U.S. vs. 12% in Israel. In other words, there is more to a successful track record than just higher exit valuations and Israel has an edge when it comes to capital efficiency and hit rate.
Thirdly, even though we’ve spent the better part of this article debunking the significance of the valuation gap, we believe that early stage investors must pay attention to this metric. Here’s why. Lower valuations — particularly in the lean and mean Israeli ecosystem — can translate into higher profitability resulting in better investor ROIs and more attractive exit multiples.
And now a word about the data. Ever since we began digging into exit data in Israel and the US, we’ve noticed that there is much more available data on the former. Having spent time on both sides of the Atlantic, we believe that this may be due to the fact that Israel is a much smaller country and journalists in Israel have it easier when it comes to accessing information. The typical Israeli just doesn’t rest until he or she finds out how many millions their neighbor brought home after an exit. It’s simply much more difficult to unearth a comparable amount of exit data for US-based startups.
We tested this by pulling CrunchBase data on California- and NYC-based tech startups versus IVC data on Israel-based companies. We found exit data on 65% of all Israeli exits since 2011, compared to only 40% and 25% of California and NYC exits, respectively. This wouldn’t be such a big issue if the sample of available information were representative of the population – but in this case it does present a problem because these samples don’t reflect reality.
Given that larger exits receive more publicity, the lack of information on exits of all sizes in the US creates an availability bias. The result? People believe that Israel typically generates smaller exits because they rarely hear about smaller exits in California. Out of the ~1,200 exits in California from 2011, we could find only 35 companies that were sold for less than $10 million.
During the same time period, out of the 360 exits in Israel, we found 50 companies that were sold for less than $10 million. We are willing to bet that out of the ~700 deals in California with undisclosed exit amounts, there are quite a few smaller transactions that would have dragged down averages.
Here’s the bottom line. The valuation gap has a lot to do with pure economics and less to do with startup quality, exit performance or investor risk/return profiles. But whether you choose to mind or not mind the valuation gap, the fact is that it exists and it’s not going away anytime soon. Investors that can look past valuation and understand the upside to investing in early stage Israeli startups can be the ones to enjoy the Wixes and Wazes of tomorrow.
This blogpost was originally published on the Wall Street Journal and has been updated for Q3 2014
Shelly Hod Moyal
Founding Partner, iAngels